Is Craneware the next UK software takeover target?

ByLance T. Lee

Sep 8, 2022

Over the past month, UK software companies Aveva (AVV) and Micro focus (MCRO) have entered the crosshairs of international buyers. As Schneider Electric (FR:SE) weighs an offer on the remaining 40% of Aveva that it does not already hold, the takeover of Micro Focus by the Canadian OpenText (CA:OTXT) advance. Meanwhile, shareholders in the Leeds-based NHS software provider Issued (ISSUED) agreed to a £1.24bn takeover by the US health insurance giant United Health (US: UNH).

Bullish points

  • Trade below peers
  • Sell ​​in the United States
  • A sticky product gives pricing power

bear dots

  • Stagnant organic growth
  • The 2021 deal now looks expensive

As the pound continues to devalue, undervalued British software companies are being taken over cheaply by overseas buyers. Edinburgh-based healthcare software company Cranware (CRW) could be the next to go. Although there are no rumors that it is being considered, current trends and Craneware’s recent devaluation below its peer group make it a likely target.

So far in 2022, Craneware’s share price has fallen 35%. Meanwhile, FactSet data shows the consensus profit forecast for the current financial year rose 22% to 81p per share. This drop in valuation, coupled with improving analyst sentiment, means the stock is now trading at an affordable PER of 19.5 for FY2023, around a 20% discount to its peers.

It’s also not hard to see what a potential acquirer might like about the business.

Craneware, which makes all of its sales in the huge US healthcare market, markets its software as a tool to connect hospital financial services to clinicians. From an operational perspective, giving hospital managers a clear view of what doctors are spending makes perfect sense, if the goal is to provide cost-effective treatment to patients. It is also essential to have systems that help hospitals stay compliant in the highly complex multi-payer healthcare system in the United States.

This is where Craneware and its Trisus platform come in. The software offers several products, including Trisus pricing, Trisus Supply and Trisus Pricing Analyzer, and has just launched the Trisus Chargemaster application, a cloud-based solution that allows hospitals to centralize all their billing data.

Unlike the UK health service, the US system is competitive. There are thousands of hospitals across the country, competing for patients and trying to generate as much profit as possible. This means getting the right price is essential. Overcharging and patients and insurers may seek treatment elsewhere. Charge too little and you risk generating a loss. The legacy of Covid-19, which resulted in a negative operating margin in a third of US hospitals in 2021, will have served as a painful reminder of these risks to hospital administrators.

M&A provides upsell opportunitiesortunity

In July last year, Craneware acquired Sentry, a Florida-based pharmacy software company. This means the Craneware Group now serves approximately 40% of all US hospitals and over 10,000 clinics and pharmacies.

The primary use of Sentry is to track pharmacy inventory to enable them to be 340B compliant. The 340B drug program is part of the Medicaid and Medicare program that provides cheaper health care to vulnerable people. The program allows pharmacies to acquire and sell drugs at discounted prices, but to do so they must accurately track where the drugs are purchased and to whom they are given. For hospital staff, paper audits of this process would have been a nightmare.

The Sentry deal was worth $400m (£345m) and at first glance it doesn’t seem too expensive. Sentry generated $92 million in revenue in 2020, valuing the company at just over four times lagging sales at a time when many US-based software-as-a-service (Saas) companies were trading more than double that level. However, forward earnings multiples have fallen by more than 50% on average since May 2021, suggesting Craneware has been buying near the top of the market.

Craneware argues that increased scale means cross-selling opportunities. Sentry has a customer base of approximately 10,000 pharmacies and clinics. It also serves 600 US hospitals, of which only 35% overlap with existing Craneware customers. This means that 390 hospitals can sell the Trisus platform.

Broker Peel Hunt said some early cross-selling to Sentry customers resulted in a 200% increase in annual recurring revenue (ARR) growth. Craneware currently earns around $85,000 per hospital, but Peel Hunt said that could go “well into six figures” as the strategy unfolds. That’s a little vague – but if Peel Hunt means $120,000, that’s implying around 40% growth in ARR even if Craneware doesn’t add any new hospitals.

Despite the clear promise of the Sentry deal, recent growth has been more modest. In fact, Sentry’s revenue and organic revenue were down 7% in the six months to December 2021, with revenue from the group’s maintenance arm – which involves on-site support with the software – contributing the bulk of the decline. These revenues are non-recurring and are only recognized as they are delivered, so they have been disrupted by Covid-19. Management expects this drop to be temporary.

“Sticky” Software Resiliencent in recession

For analysts who cover the software industry, services revenue that can rise and fall is less of a concern than a stable ARR. In the six months to December, that rose 3% to $170 million. Peel Hunt analysts said they “are not bothered by the decline in services” and forecast revenue growth of 10.6% in the 12 months to June 2023. Management appears confident of achieving these goals.

Double-digit growth for a UK software company in a potentially recessionary year would be an impressive feat, regardless of its industry orientation. But the main thing that sets Craneware apart is its exposure to the US, where the energy crisis and impending recession are unlikely to be as drastic compared to the UK and Europe.

This is likely to be good for people earning dollars like Craneware. More importantly, even if the US economy shrinks, it is unlikely to weigh heavily on healthcare spending. Compare that to Sage (SGE) – the UK’s largest SaaS company – which mainly sells to UK SMEs which are about to be battered by rising costs and the situation is much rosier for Craneware. In contrast, Sage’s much more expensive trading multiple of 24 forward earnings seems hard to justify.

Health care is essential and is among the last expenses people would cut. Staffing shortages will also encourage hospitals to spend more on technology that improves productivity. After the impact on margins during the pandemic, hospitals will look for ways to increase profitability. Craneware’s software not only frees up staff time, but also helps hospitals see where money is wasted on costly and unnecessary treatments.

We know these services are highly valued, as Craneware’s customer retention rates are over 90% across the group. This shows the stickiness of the product and makes sense. Once a hospital has moved all of its billing to one system, getting out of it would be costly. Churn from its current customers will be low, and with CPI inflators built into its US contracts, protecting its operating margins of around 20% should be straightforward.

UK markets still don’t appreciate the value of sticky software, especially when sold in the huge US market. Until they do, these companies will continue to be chosen by foreign companies and private equity firms. Craneware investors could be next in line for a payday. And if not, at least US hospitals will continue to pay their subscription fees.

Company details Last name Market cap Price 52 weeks high/low
Cranware (CRW) £569 million 1570p 2700p / 1340p
Size/debt NAV per share* Net debt* Net debt / Ebitda Operating cash/EBITDA
535p -£50.0m 1.2x 91%
Evaluation PE before (+12 months) JJ (+12 months) FCF yield (+12 months) CAP
19 2.4% 3.3% 48.8
Quality/ Growth EBIT margin ROCE CAGR of sales over 5 years CAGR EPS 5 years
16.1% 11.9% 10.8% 6.1%
Forecast / Momentum Fwd EPS grth NTM Fwd EPS grth STM Mom of 3 months Change in BPA before over 3 months
ten% 8% 13.8% 11.3%
End of year June 30 Sales ($M) Profit before tax ($ millions) EPS (c) DPS(p)
2019 71 20.6 62.0 26.0
2020 71 19.8 64.4 25.5
2021 76 17.4 68.1 25.5
Forecast 2022 165 28.6 85.1 35.2
Forecast 2023 186 34.4 93.4 36.7
To change (%) +13 +20 +10 +4
Source: FactSet, adjusted PTP and EPS figures converted to £
NTM = next 12 months; STM = Second 12 months (i.e. in one year). *Converted to £

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